It is common for owner-directors to seek to optimise their personal tax position when planning their salary package for the year ahead.
This is often achieved by paying a low salary and the remainder in dividends. The salary is typically pitched at a level that secures credit for the State Pension, without incurring any employee or employer’s National Insurance Contributions (NIC). The remainder of the remuneration package is then paid in the form of dividends. Perhaps with some employer pension contributions thrown into the mix.
Although such remuneration packages can achieve tax (primarily NIC) savings for the director/shareholder, there is one key problem….
Dividends are not a qualifying cost for R&D tax credit purposes.
So if a director/shareholder is involved in R&D projects, which can often be the case, they would only be able to claim a percentage of their low (say £8k) salary in the R&D tax credit claim. Yet their overall remuneration package might be £100,000-£150,000+ once dividends are taken into account.
Example 1 – Director/shareholder – £150,000 remuneration package (majority dividends)
Assuming a director/shareholder invests 25% of their time into the technical aspects of an R&D project and that their total remuneration package is £150,000 (made up of £8,000 salary and £142,000 dividends).
They would only be able to include 25% of the £8,000 salary in the claim as Staffing Costs. So just £2,000 added into the R&D credit calculation, despite the fact that the director had invested a quarter of the working year in one or more qualifying projects!
This would result in R&D tax savings of just £494 – £667 for the company.
Example 2 – Director/shareholder – £150,000 remuneration package (majority salary)
Applying the same facts as above, this time; however, assume that the director takes £148,000 as salary and the tax-free dividend allowance of £2,000.
In this case, the company could include 25% of £148,000 resulting in qualifying staffing costs of £37,000.
This would result in R&D tax savings of £9,139 – 12,340. A significant uplift compared to the remuneration package made up primarily of dividends.
However, we have only considered the tax savings through the lens of R&D tax credit savings. It is always important to view tax planning from a holistic perspective. This involves taking into account the tax implications for the director personally as well as for the company.
Modelling R&D tax credit benefits in director salary planning
We identified that further R&D tax credit savings might be achieved if a director/shareholder receives more of their remuneration as salary rather than dividends. This assumes that they are directly engaged in the technical aspects of the qualifying R&D project work.
But we should also consider the personal tax implications of adopting a ‘salary-loaded’ remuneration package. The easiest way to work out the cost-benefits is to crunch the numbers. It goes beyond the scope of this article, as all personal circumstances and requirements are different, but it might be that a low salary strategy works in some scenarios but not in others.
The key message to take away is that it is important that you model your optimal remuneration package with R&D tax credits in mind. Otherwise, you might just be leaving cash on the table…